Two years ago, Hong Kong’s market regulator, the Securities and Futures Commission, took accounting firm Ernst & Young to court to force it to reveal information on a Chinese utility company that had sought to be listed on the Hong Kong stock exchange. The firm, now known as EY, refused to provide audit work papers, citing legal restrictions in China. In May, a high court judge ruled in favor of the commission. EY has lodged an appeal.
Similarly, the US Securities and Exchange Commission has for years been asking for audit work papers concerning Chinese companies listed in the United States, dozens of which are alleged to have been involved in fraudulent activities. Last January, a US judge ruled in favor of the SEC and threatened to suspend Chinese affiliates of the Big Four accounting firms in China unless they provided information as requested.
On the face of it, the two cases were almost identical. But the Chinese reaction has been quite different.
Immediately after SEC Administrative Law Judge Cameron Elliot issued his ruling, a spokesman for China’s regulatory body, the China Securities Regulatory Commission, voiced “deep regret” that the SEC had “ignored” China’s efforts to promote cooperation in cross-border supervision.
“The US Securities and Exchange Commission would bear all the responsibility for the consequences of its action,” the spokesman Deng Ge said.
The previous year, CSRC had provided some information on Chinese companies requested by the SEC and, in May 2013, a memorandum of understanding was signed by CSRC, China’s Ministry of Finance, the SEC and the US Public Company Accounting Oversight Board.
Clearly, CSRC resented the SEC seeking a court ruling rather than trying to resolve the remaining issues through negotiations.
In Hong Kong, too, the Chinese government expected the SFC to go through the CSRC to resolve such issues. In fact, the SFC in 2010 did request the assistance of CSRC to obtain work papers in relation to the audit of the company Standard Water Ltd., which applied to list in Hong Kong in November 2009, with Ernst & Young as its auditor.
However, four months later, EY resigned, citing “inconsistencies in documentation in a number of areas”. Subsequently, the company withdrew its listing application.
The SFC then launched an investigation into the company, which was suspected of having provided false or misleading information. Ernst & Young said the audit had been done by Ernst & Young Hua Ming, its Beijing-based affiliate, and that there were Chinese legal impediments against the disclosure of audit documents outside the mainland.
The SFC asked CSRC for help. However, the Chinese regulator was told that it lacked jurisdiction over the utility company, which was incorporated in the Cayman Islands and whose majority shareholder was an investment holding company incorporated in the British Virgin Islands whose principal business was waste water treatment in China.
After CSRC failed to obtain the documents, the Hong Kong regulator took court action.
As it turned out, the month after its court defeat, Ernst & Young produced audit working papers sought by the SFC, saying that they had been found on various hard drives of the company in Hong Kong. In late June, it said that it needed five more weeks to complete its search of the hard drives in its Hong Kong office for additional documents sought by the SFC. Meanwhile, it has lodged an appeal against the high court judgment.
So it appears that the SFC may well get all or most of the documents that it requires and, so far, there have been no complaints from CSRC or other mainland agencies that Chinese secrecy laws are being violated.
Progress is also being made on the American front. After the Strategic & Economic Dialogue held by the US and China in early July, the two sides issued a joint fact sheet, which included a reference to the audit oversight issue. “Based on mutual respect for the national sovereignty of each country, the two sides have committed to establishing a cooperation mechanism of audit oversight that is consistent with each other’s domestic laws and regulations,” it said.
In mid-July, The Wall Street Journal quoted James Doty, chairman of the US Public Company Accounting Oversight Board, as saying that significant progress had been made, and the first US inspection of the work of Chinese audit firms was expected before the end of the year.
The resolution of the audit issue in both the US and Hong Kong is good news since it is likely to boost investor confidence as more and more Chinese companies go public to raise capital. It should be good for both Chinese companies and overseas investors.
Frank Ching is a Hong Kong-based writer on Chinese affairs.
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